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Authors Michelle Connolly and Jenessa Gunther find that the South American customs union known as Mercosur has helped advance trade liberalization within the region, but may be encouraging trade diversion and limiting member countries access to high-technology imports, an important stimulus to growth.

The Mercosur agreement, formed by Argentina, Brazil, Paraguay, and Uruguay in 1991, requires members to liberalize trade with one another while imposing a common external tariff on goods imported from countries outside the union. As expected, these provisions have led to a marked expansion in trade between members: intra-Mercosur trade as a share of member countries total trade rose from roughly 12 percent in 1991 to a high of about 19 percent in 1994.

Much of this new internal trade, however, involves products in which the Mercosur countries are not particularly competitive, according to a World Bank study cited by Connolly and Gunther. Consequently, members are importing high-cost goods from their partners in place of goods produced more efficiently by nonmembers. This phenomenon--known as "trade diversion"--is particularly apparent in such manufacturing industries as machinery and transportation equipment.

The authors go on to consider how the make-up of Mercosur and the trade diversion that appears to be taking place may be affecting the rate of economic growth in member countries. These "dynamic" effects, Connolly and Gunther note, have largely been overlooked in earlier studies of the pros and cons of Mercosur and other regional trade arrangements.

Because Mercosur is composed exclusively of developing countries and promotes intra-group trade over trade with nonmembers, it may limit members access to high-technology imports from industrialized nations, Connolly and Gunther state. This outcome is especially likely given the evidence that trade diversion is occurring in technology-driven industries. Earlier work by Connolly shows that exposure to high-technology products can significantly accelerate growth and innovation in the countries importing those goods. Building on this finding, the authors conclude that in forgoing freer trade relations with the rest of the world, Mercosur countries may be undercutting their own potential for faster growth.